2026 Cambridge IAS-Level Accounting (9706) Practice Paper with Answers

1. Initial ordinary shares = 400\,000 shares.
2. Rights issue: \(400\,000 / 4 = 100\,000\) new ordinary shares.
Premium per share = \(\$0.80 - \$0.50 = \$0.30\).
Total premium from rights issue = \(100\,000 \times \$0.30 = \$30\,000\).
Share premium balance after rights issue = \(\$65\,000 + \$30\,000 = \$95\,000\).

3. Total number of shares before bonus issue = \(400\,000 + 100\,000 = 500\,000\) shares.
Bonus shares issued: \(500\,000 / 5 = 100\,000\) ordinary shares.
Nominal value of bonus issue = \(100\,000 \times \$0.50 = \$50\,000\).

4. The bonus issue is funded using the share premium account (a non-distributable capital reserve):
Closing share premium balance = \(\$95\,000 - \$50\,000 = \$45\,000\).

B is correct ($45\,000).

A ($15\,000) incorrectly calculates the bonus issue based on the total value or deducts $80\,000.
C ($55\,000) incorrectly computes the bonus issue on original 400\,000 shares instead of post-rights 500\,000 shares ($95\,000 - $40\,000).
D ($95\,000) fails to deduct the bonus issue from the share premium reserve.

Draft sales ledger control account balance = $84\,600 (Dr)

Adjustments:
1. Irrecoverable debt omitted: Credit $1\,400 (subtract $1\,400)
2. Sales returns journal overcast by $650: Sales returns journal total is posted to the credit of the control account. Being overcast by $650 means too much was credited, so debit $650 (add $650)
3. Contra entry of $900 entered on debit side instead of credit side: Credit \(2 \times \$900 = \$1\,800\) (subtract $1\,800)
4. Cash received omitted from control account: Credit $2\,150 (subtract $2\,150)

Corrected balance = \(\$84\,600 - \$1\,400 + \$650 - \$1\,800 - \$2\,150 = \$79\,900\).

A is correct ($79\,900).

B ($81\,700) neglects the double adjustment needed for the contra error (only deducts $900 once instead of $1\,800).
C ($80\,200) subtracts the $650 overcast instead of adding it back.
D ($83\,500) misidentifies the direction of cash received and contra entries.

1. Calculate contribution per unit:
- Product X: \(48 - (16 + 18 + 5) = 48 - 39 = \$9\)
- Product Y: \(60 - (20 + 12 + 7) = 60 - 39 = \$21\)

2. Calculate direct material required per unit:
- Product X: \(\$16 / \$4 = 4\text{ kg}\)
- Product Y: \(\$20 / \$4 = 5\text{ kg}\)

3. Calculate contribution per kg of limiting factor:
- Product X: \(\$9 / 4\text{ kg} = \$2.25\text{ per kg}\)
- Product Y: \(\$21 / 5\text{ kg} = \$4.20\text{ per kg}\)

Ranking: 1st Product Y, 2nd Product X.

4. Allocation of 11\,000 kg:
- Product Y: \(1\,500\text{ units} \times 5\text{ kg} = 7\,500\text{ kg}\).
- Remaining material = \(11\,000 - 7\,500 = 3\,500\text{ kg}\).
- Product X: \(3\,500\text{ kg} / 4\text{ kg per unit} = 875\text{ units}\).

Therefore, the optimal production plan is 875 units of X and 1\,500 units of Y.

C is correct (875 units of X and 1\,500 units of Y).

A (1\,200 units of X and 1\,240 units of Y) incorrectly prioritises Product X first.
B (1\,200 units of X and 1\,500 units of Y) requires 12\,300 kg, exceeding available material.
D (1\,000 units of X and 1\,400 units of Y) is an arbitrary allocation that does not maximise contribution.

1. New selling price = \(\$80 \times (1 - 0.10) = \$72\).
2. Variable cost per unit = \(\$48\).
3. New contribution per unit = \(\$72 - \$48 = \$24\).
4. Required total contribution = \(\text{Fixed overheads} + \text{Target profit} = \$192\,000 + \$160\,000 = \$352\,000\).
5. Required sales volume = \(\frac{\$352\,000}{\$24} = 14\,667\text{ units}\) (rounded to nearest unit) or precisely \(14\,666.67\).

Let's verify: \(14\,666.67 \times \$24 = \$352\,000\).
Matches 14\,667 units.

D is correct (14\,667 units).

A (11\,000 units) uses original contribution of $32 ($352\,000 / $32 = 11\,000).
B (8\,000 units) calculates break-even volume with new price ($192\,000 / $24 = 8\,000).
C (13\,500 units) miscalculates new contribution as \(\$26\).

1. Start with the bank statement balance: \(-\$5\,820\) (Overdrawn)
2. Add bank error (fee deducted twice, bank will credit): \(+\$120\)
3. Add uncredited receipts: \(+\$2\,180\)
4. Less unpresented cheques: \(-\$3\,450\)

Corrected / Updated Cash Book Balance = \(-\$5\,820 + \$120 + \$2\,180 - \$3\,450 = -\$6\,970\) (Overdrawn / Credit balance $6\,970).

5. To find the unadjusted (original) Cash Book balance before item (3) was recorded:
Unadjusted Cash Book balance \(-\$490 = -\$6\,970\)
Unadjusted Cash Book balance = \(-\$6\,970 + \$490 = -\$6\,480\) (Overdrawn).

B is correct ($6\,480 overdrawn).

A ($6\,970 overdrawn) gives the corrected cash book balance after updating for the direct debit.
C ($7\,460 overdrawn) incorrectly subtracts $490 from \(-\$6\,970\).
D ($6\,240 overdrawn) misapplies the bank error correction.

1. Profit for the year = Profit from operations \(-\) Finance costs
\(= \$142\,000 - \$18\,000 = \$124\,000\).

2. According to standard accounting rules, proposed dividends are not recognized as a liability or deducted from equity until approved; only paid dividends are deducted.

3. Movement in retained earnings:
Opening retained earnings = $214\,000
Add: Profit for the year = \(+\$124\,000\)
Less: Transfer to general reserve = \(-\$25\,000\)
Less: Interim dividend paid = \(-\$30\,000\)

Closing retained earnings = \(\$214\,000 + \$124\,000 - \$25\,000 - \$30\,000 = \$283\,000\).

C is correct ($283\,000).

A ($238\,000) incorrectly deducts the proposed final dividend of $45\,000.
B ($265\,000) omits the deduction for the finance costs from profit.
D ($308\,000) fails to deduct the transfer to the general reserve.

1. Predetermined Overhead Absorption Rate (OAR):
\(\text{OAR} = \frac{\text{Budgeted Overheads}}{\text{Budgeted Machine Hours}} = \frac{\$360\,000}{45\,000\text{ hours}} = \$8.00\text{ per machine hour}\).

2. Overheads Absorbed:
\(\text{Absorbed Overheads} = \text{Actual Hours} \times \text{OAR} = 46\,500 \times \$8.00 = \$372\,000\).

3. Over/Under-absorption:
\(\text{Under-absorption} = \text{Actual Overheads} - \text{Absorbed Overheads} = \$382\,000 - \$372\,000 = \$10\,000\text{ under-absorbed}\).

B is correct ($10\,000 under-absorbed).

A ($10\,000 over-absorbed) confuses under-absorption with over-absorption.
C ($22\,000 under-absorbed) is merely the difference between actual overheads and budgeted overheads ($382\,000 - $360\,000).
D ($12\,000 over-absorbed) calculates the volume variance without comparing to actual expenditure.

1. Calculate Gross Profit: \(25\% \times \$480\,000 = \$120\,000\).
2. Calculate Cost of Sales: \(\text{Revenue} - \text{Gross Profit} = \$480\,000 - \$120\,000 = \$360\,000\).
3. Calculate Average Inventory: \(\frac{\$32\,000 + \$40\,000}{2} = \$36\,000\).
4. Rate of inventory turnover (times): \(\frac{\text{Cost of Sales}}{\text{Average Inventory}} = \frac{\$360\,000}{\$36\,000} = 10.0\text{ times}\).

A is correct (10.0 times).

B (13.3 times) incorrectly uses Revenue instead of Cost of Sales ($480\,000 / $36\,000).
C (9.0 times) incorrectly divides Cost of Sales by Closing Inventory ($360\,000 / $40\,000).
D (11.25 times) incorrectly divides Cost of Sales by Opening Inventory ($360\,000 / $32\,000).

1. Bonus issue:
- Number of bonus shares = \(400\,000 \times \frac{1}{4} = 100\,000\text{ shares}\)
- Nominal value of bonus shares = \(100\,000 \times \$0.50 = \$50\,000\)
- Financed from share premium, reducing the balance from \(\$60\,000\) to \(\$10\,000\).
- Total shares in issue after bonus issue = \(400\,000 + 100\,000 = 500\,000\text{ shares}\).

2. Rights issue:
- Number of rights shares = \(500\,000 \times \frac{1}{5} = 100\,000\text{ shares}\)
- Issue price = \(\$0.80\); Nominal value = \(\$0.50\); Premium per share = \(\$0.30\)
- Share premium created = \(100\,000 \times \$0.30 = \$30\,000\)

Final share premium balance = \(\$10\,000 + \$30\,000 = \$40\,000\).

[1 mark] B is correct. Calculation of bonus issue deduction of $50 000 leaving $10 000, followed by rights issue addition of $30 000 (100 000 shares × $0.30 premium), giving $40 000.

Starting draft profit = \(\$62\,400\)

- Error 1: Add back office expenses \(+\$3\,000\); deduct depreciation \(-\$300\) (\(10\% \times \$3\,000\)) \(\rightarrow +\$2\,700\)
- Error 2: Sales journal overcast reduces sales and profit \(\rightarrow -\$800\)
- Error 3: Rent in advance should be removed from income \(\rightarrow -\$450\)
- Error 4: Remove incorrect expense \(+\$350\) and record intended income reduction \(+\$350\) \(\rightarrow +\$700\)

Corrected profit = \(\$62\,400 + \$2\,700 - \$800 - \$450 + \$700 = \$64\,550\).

[1 mark] C is correct. Net adjustment: +$2 700 (capital expenditure correction) - $800 (sales overcast) - $450 (prepaid income) + $700 (allowance reversal and correct adjustment) = +$2 150. Draft profit $62 400 + $2 150 = $64 550.

Draft balance = \(\$34\,820\text{ (Credit)}\)

- Contra entry: Should be debited; was credited. Correction requires debit of \(2 \times \$640 = -\$1\,280\).
- Discounts received: Debited to control account \(\rightarrow -\$290\).
- Purchases day book undercast: Credit to control account was understated \(\rightarrow +\$1\,100\).
- Overstated purchase invoice (\(\$540 - \$450 = \$90\)): Credit was overstated, correct by debiting \(\rightarrow -\$90\).

Corrected balance = \(\$34\,820 - \$1\,280 - \$290 + \$1\,100 - \$90 = \$34\,260\text{ (Credit)}\).

[1 mark] A is correct. $34 820 - $1 280 (contra correction) - $290 (discount received) + $1 100 (purchases undercast) - $90 (invoice overstatement) = $34 260.

1. Contribution per unit:
- Product X: \(\$50 - \$16 - \$12 - \$6 = \$16\)
- Product Y: \(\$70 - \$24 - \$18 - \$10 = \$18\)
- Product Z: \(\$42 - \$12 - \$11 - \$4 = \$15\)

2. Material kg per unit:
- Product X: \(\$16 / \$4 = 4\text{ kg}\)
- Product Y: \(\$24 / \$4 = 6\text{ kg}\)
- Product Z: \(\$12 / \$4 = 3\text{ kg}\)

3. Contribution per kg of limiting factor:
- Product X: \(\$16 / 4\text{ kg} = \$4.00\text{ per kg}\) (Rank 2)
- Product Y: \(\$18 / 6\text{ kg} = \$3.00\text{ per kg}\) (Rank 3)
- Product Z: \(\$15 / 3\text{ kg} = \$5.00\text{ per kg}\) (Rank 1)

4. Production plan:
- Product Z (Rank 1): \(600\text{ units} \times 3\text{ kg} = 1\,800\text{ kg}\). Contribution = \(600 \times \$15 = \$9\,000\).
- Remaining material = \(3\,200 - 1\,800 = 1\,400\text{ kg}\).
- Product X (Rank 2): \(1\,400\text{ kg} / 4\text{ kg} = 350\text{ units}\). Contribution = \(350 \times \$16 = \$5\,600\).
- Product Y (Rank 3): 0 units.

Total maximum contribution = \(\$9\,000 + \$5\,600 = \$14\,600\).

[1 mark] C is correct. Ranking by contribution per kg: Z ($5/kg), X ($4/kg), Y ($3/kg). Producing 600 units of Z (1 800 kg) yields $9 000; producing 350 units of X (1 400 kg) yields $5 600; total contribution = $14 600.

1. Current situation:
- Contribution per unit = \(\$60 - \$36 = \$24\)
- Total contribution required = \(\text{Fixed costs} + \text{Target profit} = \$180\,000 + \$72\,000 = \$252\,000\)
- Required sales volume = \(\frac{\$252\,000}{\$24} = 10\,500\text{ units}\)

2. Proposed situation:
- New selling price = \(\$60 \times 1.10 = \$66\)
- New contribution per unit = \(\$66 - \$36 = \$30\)
- New fixed costs = \(\$180\,000 + \$18\,000 = \$198\,000\)
- Total contribution required = \(\$198\,000 + \$72\,000 = \$270\,000\)
- Required sales volume = \(\frac{\$270\,000}{\$30} = 9\,000\text{ units}\)

Change in sales volume = \(10\,500 - 9\,000 = 1\,500\text{ units decrease}\).

[1 mark] A is correct. Current volume = 10 500 units; proposed volume = 9 000 units. Difference is a decrease of 1 500 units.

1. Total units available for sale:
\(200 + 300 + 500 = 1\,000\text{ units}\)

2. Total cost of inventory available:
- May 1: \(200 \times \$15 = \$3\,000\)
- May 8: \(300 \times \$18 = \$5\,400\)
- May 22: \(500 \times \$21 = \$10\,500\)
- Total cost = \(\$3\,000 + \$5\,400 + \$10\,500 = \$18\,900\)

3. Periodic weighted average cost per unit:
\(\frac{\$18\,900}{1\,000\text{ units}} = \$18.90\text{ per unit}\)

4. Closing inventory units:
\(1\,000 - (320 + 280) = 400\text{ units}\)

5. Closing inventory valuation:
\(400\text{ units} \times \$18.90 = \$7\,560\).

[1 mark] B is correct. Periodic AVCO calculation: Total cost $18 900 / 1 000 units = $18.90/unit. Closing inventory of 400 units × $18.90 = $7 560.

1. Initial revenue reserves = General reserve (\(\$45\,000\)) + Retained earnings (\(\$130\,000\)) = \(\$175\,000\).

2. Bonus issue:
- Bonus shares = \(500\,000 \times \frac{1}{10} = 50\,000\text{ shares}\) \(\rightarrow \$50\,000\).
- To maintain maximum flexibility, capital reserves (share premium) are used first. Share premium of \(\$50\,000\) is used, leaving revenue reserves unchanged.

3. Total shares in issue after bonus issue = \(500\,000 + 50\,000 = 550\,000\text{ shares}\).

4. Interim dividend paid = \(550\,000 \times \$0.05 = \$27\,500\) (deducted from retained earnings).

5. Profit for the year = \(+\$95\,000\) (added to retained earnings).

6. Transfer of \(\$20\,000\) from retained earnings to general reserve does not change total revenue reserves.

Total revenue reserves at 31 December 2024 = \(\$175\,000 + \$95\,000 - \$27\,500 = \$242\,500\).

[1 mark] C is correct. Initial revenue reserves $175 000 + profit $95 000 - dividend on 550 000 shares $27 500 = $242 500 (bonus issue is charged to share premium; transfer between reserves has zero net effect).

1. Existing shares = 400 000 shares of $0.50.
Bonus issue = \(\frac{1}{4} \times 400\,000 = 100\,000\) shares.
Nominal value of bonus issue = \(100\,000 \times \$0.50 = \$50\,000\).
To preserve revenue reserves (retained earnings), the share premium is used first.
Share premium utilised = $35 000 (exhausting the balance to $0), and the remaining $15 000 is funded from retained earnings.

2. Number of shares after bonus issue = \(400\,000 + 100\,000 = 500\,000\) shares.
Rights issue = \(\frac{1}{5} \times 500\,000 = 100\,000\) shares at $0.80.
Premium per rights share = \(\$0.80 - \$0.50 = \$0.30\).
Share premium created = \(100\,000 \times \$0.30 = \$30\,000\).

Final share premium balance = \(\$0 + \$30\,000 = \$30\,000\).

B is correct [1 mark]. Calculation: Share premium utilised in full on bonus issue ($35 000 - $35 000 = $0) and rights issue premium added (100 000 × $0.30 = $30 000).

1. Rights issue:
- Number of rights shares issued = \(400\,000 \times \frac{1}{4} = 100\,000\) shares.
- Premium per share = \(\$0.80 - \$0.50 = \$0.30\).
- Total premium received from rights issue = \(100\,000 \times \$0.30 = \$30\,000\).
- Share premium balance before bonus issue = \(\$60\,000 + \$30\,000 = \$90\,000\).

2. Bonus issue:
- Total shares in issue after rights issue = \(400\,000 + 100\,000 = 500\,000\) shares.
- Number of bonus shares issued = \(500\,000 \times \frac{1}{5} = 100\,000\) shares.
- Nominal value of bonus issue = \(100\,000 \times \$0.50 = \$50\,000\).
- Reduction in share premium = \(\$50\,000\).

3. Final share premium balance = \(\$90\,000 - \$50\,000 = \$40\,000\).

B is correct [1 mark].
Method breakdown:
- Calculate rights issue premium additions (+$30 000) and updated share capital.
- Calculate bonus issue reduction from share premium (-$50 000).
- Resulting balance is $40 000.

Analysis of errors on profit:
1. Error 1: Debiting purchases returns instead of sales returns. Both sales returns and purchases returns reduce gross profit by $750 when debited. Correcting this shifts $750 from purchases returns to sales returns, resulting in a net effect of $0 on profit.
2. Error 2: Rent received of $1 200 was debited to rent expense instead of credited to rent receivable. Correcting the expense increases profit by $1 200, and recognizing the income increases profit by $1 200. Total increase in profit = \(+\$2\,400\).
3. Error 3: Discount allowed of $450 was omitted from expenses in the general ledger. Recording this expense reduces profit by $450.

Correct profit = \(\$84\,200 + \$0 + \$2\,400 - \$450 = \$86\,150\).

C is correct [1 mark].
Method breakdown:
- Error 1: $0 net impact on profit.
- Error 2: +$2 400 correction.
- Error 3: -$450 correction.
- Correct profit = $86 150.

1. Update the cash book balance:
- Initial overdraft: \(-\$4\,850\)
- Bank charges: \(-\$185\)
- Standing order: \(-\$320\)
- Dishonoured cheque: \(-\$640\)
- Updated cash book balance = \(-\$4\,850 - \$185 - \$320 - \$640 = -\$5\,995\) (credit balance / overdraft).

2. Reconcile to bank statement balance \(B\):
\(B + \text{Uncredited deposits} - \text{Unpresented cheques} = \text{Updated cash book balance}\)
\(B + \$3\,670 - \$2\,140 = -\$5\,995\)
\(B + \$1\,530 = -\$5\,995\)
\(B = -\$5\,995 - \$1\,530 = -\$7\,525\)

A negative bank statement balance of $7 525 represents an overdraft (debit balance on the bank statement).

D is correct [1 mark].
Method breakdown:
- Updated cash book balance = $5 995 credit.
- Bank statement balance = -$5 995 - $3 670 + $2 140 = -$7 525 (debit).

1. Depreciation calculation:
- Year 2023: \(20\% \times \$32\,000 = \$6\,400\). Carrying amount at 31 December 2023 = \(\$32\,000 - \$6\,400 = \$25\,600\).
- Year 2024: \(20\% \times \$25\,600 = \$5\,120\). Carrying amount at 31 December 2024 = \(\$25\,600 - \$5\,120 = \$20\,480\).
- Year 2025: No depreciation is charged in the year of disposal.

2. Profit/loss on disposal:
- Carrying amount at date of disposal = \(\$20\,480\).
- Trade-in value (disposal proceeds) = \(\$18\,500\).
- Loss on disposal = \(\$20\,480 - \$18\,500 = \$1\,980\).

A is correct [1 mark].
Method breakdown:
- 2023 depreciation = $6 400; 2024 depreciation = $5 120.
- Carrying amount = $20 480.
- Loss on disposal = $20 480 - $18 500 = $1 980 loss.

1. Contribution per unit:
- Product X: \(\$50 - (\$16 + \$14 + \$4) = \$50 - \$34 = \$16\)
- Product Y: \(\$65 - (\$24 + \$15 + \$5) = \$65 - \$44 = \$21\)
- Product Z: \(\$36 - (\$8 + \$12 + \$6) = \$36 - \$26 = \$10\)

2. Material quantity per unit:
- Product X: \(\frac{\$16}{\$4} = 4\text{ kg}\)
- Product Y: \(\frac{\$24}{\$4} = 6\text{ kg}\)
- Product Z: \(\frac{\$8}{\$4} = 2\text{ kg}\)

3. Contribution per kg of limiting factor:
- Product X: \(\frac{\$16}{4\text{ kg}} = \$4.00\text{ per kg}\) (Rank 2)
- Product Y: \(\frac{\$21}{6\text{ kg}} = \$3.50\text{ per kg}\) (Rank 3)
- Product Z: \(\frac{\$10}{2\text{ kg}} = \$5.00\text{ per kg}\) (Rank 1)

Order of priority: Z, X, Y.

C is correct [1 mark].
Method breakdown:
- Calculate unit contributions: X = $16, Y = $21, Z = $10.
- Calculate contribution per kg: X = $4.00, Y = $3.50, Z = $5.00.
- Rank from highest to lowest: Z, X, Y.

1. Contribution per unit = \(\text{Selling price} - \text{Variable cost} = \$50 - \$30 = \$20\).

2. Break-even output = \(\frac{\text{Fixed costs}}{\text{Contribution per unit}} = \frac{\$180\,000}{\$20} = 9\,000\text{ units}\).

3. Required output for target profit = \(\frac{\text{Fixed costs} + \text{Target profit}}{\text{Contribution per unit}} = \frac{\$180\,000 + \$60\,000}{\$20} = \frac{\$240\,000}{\$20} = 12\,000\text{ units}\).

4. Margin of safety in units = \(\text{Target sales} - \text{Break-even sales} = 12\,000 - 9\,000 = 3\,000\text{ units}\).

A is correct [1 mark].
Method breakdown:
- Contribution per unit = $20.
- Break-even units = 9 000.
- Target sales units = 12 000.
- Margin of safety = 12 000 - 9 000 = 3 000 units.

1. Predetermined overhead absorption rate (OAR):
$$\text{OAR} = \frac{\text{Budgeted overheads}}{\text{Budgeted labour hours}} = \frac{\$360\,000}{45\,000} = \$8.00\text{ per direct labour hour}$$

2. Overheads absorbed:
$$\text{Overheads absorbed} = \text{Actual direct labour hours} \times \text{OAR} = 49\,000 \times \$8.00 = \$392\,000$$

3. Under/over-absorption:
$$\text{Over-absorption} = \text{Overheads absorbed} - \text{Actual overheads incurred} = \$392\,000 - \$382\,500 = \$9\,500\text{ over-absorbed}$$
Since absorbed overheads exceed actual overheads, overheads are over-absorbed.

B is correct [1 mark].
Method breakdown:
- OAR = $8.00/hour.
- Absorbed = 49 000 × $8 = $392 000.
- Variance = $392 000 - $382 500 = $9 500 over-absorbed.

1. Profit from operations (operating profit):
$$\text{Profit from operations} = \text{Gross profit} - \text{Operating expenses} = \$320\,000 - \$200\,000 = \$120\,000$$

2. Capital employed:
$$\text{Capital employed} = \text{Total equity} + \text{Non-current liabilities} = \$450\,000 + \$150\,000 = \$600\,000$$

3. ROCE:
$$\text{ROCE} = \left(\frac{\text{Profit from operations}}{\text{Capital employed}}\right) \times 100 = \left(\frac{\$120\,000}{\$600\,000}\right) \times 100 = 20.00\%$$

B is correct [1 mark].
Method breakdown:
- Profit from operations = $120 000.
- Capital employed = $600 000.
- ROCE = ($120 000 / $600 000) × 100 = 20.00%.

1. Initial balances:
- Ordinary share capital: \(400\,000 \times \$0.50 = \$200\,000\)
- Share premium: $60 000

2. Bonus issue:
- New shares issued: \(\frac{400\,000}{4} = 100\,000\text{ shares}\)
- Nominal value of bonus issue: \(100\,000 \times \$0.50 = \$50\,000\)
- Share premium is reduced by $50 000 to \(\$60\,000 - \$50\,000 = \$10\,000\)
- Ordinary share capital becomes \(\$200\,000 + \$50\,000 = \$250\,000\) (representing 500 000 shares of $0.50 each).

3. Rights issue:
- New shares issued: \(\frac{500\,000}{5} = 100\,000\text{ shares}\)
- Nominal value added to share capital: \(100\,000 \times \$0.50 = \$50\,000\)
- Premium added to share premium account: \(100\,000 \times (\$0.80 - \$0.50) = \$30\,000\)

4. Final balances:
- Ordinary share capital: \(\$250\,000 + \$50\,000 = \$300\,000\)
- Share premium: \(\$10\,000 + \$30\,000 = \$40\,000\)
- Total combined balance: \(\$300\,000 + \$40\,000 = \$340\,000\).

Award 1 mark for C ($340 000).

Distractor rationales:
- A ($290 000): Omitted the rights issue premium or miscalculated share counts.
- B ($310 000): Failed to apply the rights issue to the post-bonus share count.
- D ($390 000): Double-counted the bonus issue or treated rights proceeds wholly as capital.

Analysis of the correcting entries required:

1. Error 1: Sales returns (which requires a debit of $1 400) was credited to purchases returns ($1 400 credit instead of debit).
- Correcting entry: Debit Sales returns $1 400, Debit Purchases returns $1 400, Credit Suspense $2 800.

2. Error 2: Discount allowed should be debited ($250) but was debited to discount received ($250). Both are debits, so the trial balance totals are not affected.
- Correcting entry: Debit Discount allowed $250, Credit Discount received $250. (No suspense entry).

3. Error 3: Cash book credited $620, but motor vehicles debited $260 (under-debited by $360).
- Correcting entry: Debit Motor vehicle repairs $620, Credit Motor vehicles $260, Credit Suspense $360.

Total suspense correction entries: \(\text{Credit } \$2\,800 + \text{Credit } \$360 = \$3\,160\text{ Credit}\).

Therefore, to be cleared by a credit of $3 160, the original opening balance on the suspense account must have been $3 160 Debit.

Award 1 mark for C ($3 160 debit).

Distractor rationales:
- A ($1 780 debit): Adjusted error 1 by only $1 400 instead of $2 800.
- B ($2 030 credit): Reversed the required suspense balance direction and included discount received.
- D ($3 660 credit): Included error 2 and misallocated the debit/credit nature.

1. Calculate unit contribution for each product:
- Product X:
\(\text{Variable cost} = \$16 + \$12 + \$5 = \$33\)
\(\text{Contribution per unit} = \$45 - \$33 = \$12\)
- Product Y:
\(\text{Variable cost} = \$24 + \$18 + \$6 = \$48\)
\(\text{Contribution per unit} = \$60 - \$48 = \$12\)

2. Calculate material usage per unit:
- Product X: \(\frac{\$16}{\$4\text{ per kg}} = 4\text{ kg}\)
- Product Y: \(\frac{\$24}{\$4\text{ per kg}} = 6\text{ kg}\)

3. Calculate contribution per kg of limiting factor:
- Product X: \(\frac{\$12}{4\text{ kg}} = \$3.00\text{ per kg}\)
- Product Y: \(\frac{\$12}{6\text{ kg}} = \$2.00\text{ per kg}\)

Product X provides a higher contribution per kg ($3.00) and should be prioritised.

Award 1 mark for A (Product X, $3.00).

Distractor rationales:
- B (Product X, $12.00): Stated total contribution per unit rather than contribution per kg of material.
- C (Product Y, $2.00): Calculated the lower-ranked product.
- D (Product Y, $8.00): Incorrectly divided contribution by direct labour hours instead of material kg.

1. Current situation:
- Current contribution per unit: \(\$80 - \$48 = \$32\)
- Current total contribution: \(8\,000 \times \$32 = \$256\,000\)
- Current profit: \(\$256\,000 - \$192\,000 = \$64\,000\)

2. Proposed situation:
- New selling price per unit: \(\$80 \times 0.90 = \$72\)
- New contribution per unit: \(\$72 - \$48 = \$24\)
- New sales volume: \(8\,000 \times 1.25 = 10\,000\text{ units}\)
- New total contribution: \(10\,000 \times \$24 = \$240\,000\)
- New profit: \(\$240\,000 - \$192\,000 = \$48\,000\)

3. Change in profit:
- \(\$48\,000 - \$64\,000 = -\$16\,000\) (decrease of $16 000).

Award 1 mark for A (decrease by $16 000).

Distractor rationales:
- B (increase by $16 000): Inverted the change in profit.
- C (decrease by $32 000): Computed contribution change without taking into account the increased sales volume.
- D (increase by $48 000): Confused final profit with change in profit.

1. Disposal calculation:
- Cost of machine disposed: $32 000
- Years of depreciation charged: 2020, 2021, and 2022 (3 years; none in year of disposal 2023)
- Accumulated depreciation on disposed machine: \(3 \times (20\% \times \$32\,000) = 3 \times \$6\,400 = \$19\,200\)
- Carrying amount (net book value) at disposal: \(\$32\,000 - \$19\,200 = \$12\,800\)
- Part-exchange allowance (proceeds): $11 000
- Loss on disposal: \(\$12\,800 - \$11\,000 = \$1\,800\text{ Loss}\)

2. Depreciation charge for the year ended 31 December 2023:
- Cost of remaining existing machines: \(\$140\,000 - \$32\,000 = \$108\,000\)
- Cost of new machine acquired: $48 000
- Total cost of machines owned at 31 December 2023: \(\$108\,000 + \$48\,000 = \$156\,000\)
- Depreciation charge: \(20\% \times \$156\,000 = \$31\,200\).

Award 1 mark for A (Loss on disposal $1 800; Depreciation charge $31 200).

Distractor rationales:
- B: Charged half a year's depreciation on the disposed asset in 2023 contrary to the stated accounting policy.
- C: Calculated a profit by subtracting part-exchange value from the original cost minus 4 years of depreciation.
- D: Omitted the new asset from the year-end depreciation charge.

1. Total units available during the period:
\(200\text{ (opening)} + 300\text{ (8 April)} + 500\text{ (22 April)} = 1\,000\text{ units}\)

2. Total cost of units available:
- Opening inventory: \(200 \times \$14 = \$2\,800\)
- Purchases on 8 April: \(300 \times \$16 = \$4\,800\)
- Purchases on 22 April: \(500 \times \$18 = \$9\,000\)
- Total cost: \(\$2\,800 + \$4\,800 + \$9\,000 = \$16\,600\)

3. Periodic weighted average cost per unit:
\(\frac{\$16\,600}{1\,000\text{ units}} = \$16.60\text{ per unit}\)

4. Closing inventory units:
\(1\,000 - 400 - 350 = 250\text{ units}\)

5. Valuation of closing inventory:
\(250\text{ units} \times \$16.60 = \$4\,150\).

Award 1 mark for B ($4 150).

Distractor rationales:
- A ($3 750): Simple arithmetic average of unit purchase costs \((14 + 16 + 18)/3 = \$16.00\times 250\) minus rounding error or simple opening cost applied.
- C ($4 383): Calculated using perpetual AVCO instead of periodic AVCO.
- D ($4 500): Calculated using First In, First Out (FIFO) (\(250 \times \$18 = \$4\,500\)).

### (a) Structured Workings

(i) Cost of sales:
- Damaged inventory net realisable value (NRV) = $$3\,200 - \$600 = \$2\,600\$
- Valuation reduction = $$5\,000 - $2\,600 = $2\,400$
- Adjusted closing inventory = $$48\,000 - \$2\,400 = \$45\,600\$
$$\text{Cost of sales} = \text{Opening inventory } (\$42\,000) + \text{Purchases } (\$318\,000) + \text{Carriage inwards } (\$6\,000) - \text{Closing inventory } (\$45\,600) = \$320\,400$$

(ii) Distribution costs:
- Equipment depreciation total = \$(\$120\,000 - \$48\,000) \times 20\% = \$72\,000 \times 20\% = \$14\,400\$
- Distribution share of depreciation = \$60\% \times \$14\,400 = \$8\,640\$
$$\text{Distribution costs} = \text{Trial balance } (\$51\,000) + \text{Accrual } (\$1\,640) + \text{Depreciation } (\$8\,640) = \$61\,280$$

(iii) Administrative expenses:
- Premises depreciation = $$350\,000 \times 2\% = $7\,000$
- Equipment depreciation share = $40\% \times $14\,400 = $5\,760$
- Irrecoverable debt written off = $$3\,000\$
- Remaining trade receivables = $$65\,000 - $3\,000 = $62\,000$
- Required allowance = $4\% \times $62\,000 = $2\,480$
- Reduction in allowance = $$2\,500 - \$2\,480 = (\$20)\$
$$\text{Administrative expenses} = \$74\,000 - \text{Prepayment } (\$2\,800) + \text{Premises dep } (\$7\,000) + \text{Equipment dep } (\$5\,760) + \text{Bad debt } (\$3\,000) - \text{Allowance reduction } (\$20) = \$86\,940$$

---

### (b) Aventis Retail Ltd — Statement of Profit or Loss for the year ended 31 December 2025

$$\begin{array}{lrr}
& \$ & \$ \\
\hline
\text{Revenue} & & 640\,000 \\
\text{Cost of sales} & & (320\,400) \\
\hline
\textbf{Gross profit} & & \mathbf{319\,600} \\
\text{Distribution costs} & (61\,280) & \\
\text{Administrative expenses} & (86\,940) & (148\,220) \\
\hline
\textbf{Profit from operations} & & \mathbf{171\,380} \\
\text{Finance costs } (\$50\,000 \times 6\%) & & (3\,000) \\
\hline
\textbf{Profit for the year} & & \mathbf{168\,380} \\
\hline
\end{array}$$

---

### (c) Aventis Retail Ltd — Statement of Changes in Equity for the year ended 31 December 2025

$$\begin{array}{|l|r|r|r|r|r|}
\hline
& \begin{array}{c}\text{Share} \\ \text{Capital } (\$)\end{array} & \begin{array}{c}\text{Share} \\ \text{Premium } (\$)\end{array} & \begin{array}{c}\text{General} \\ \text{Reserve } (\$)\end{array} & \begin{array}{c}\text{Retained} \\ \text{Earnings } (\$)\end{array} & \begin{array}{c}\text{Total} \\ (\$)\end{array} \\
\hline
\text{Balance at 1 January 2025} & 200\,000 & 30\,000 & 25\,000 & 46\,000 & 301\,000 \\
\text{Profit for the year} & - & - & - & 168\,380 & 168\,380 \\
\text{Transfer to general reserve} & - & - & 15\,000 & (15\,000) & - \\
\text{Dividends paid} & - & - & - & (10\,000) & (10\,000) \\
\hline
\textbf{Balance at 31 December 2025} & \mathbf{200\,000} & \mathbf{30\,000} & \mathbf{40\,000} & \mathbf{189\,380} & \mathbf{459\,380} \\
\hline
\end{array}$$

---

### (d) Ratio Calculations

**(i) Profit margin:**
$$\text{Profit margin} = \left(\frac{\text{Profit for the year}}{\text{Revenue}}\right) \times 100 = \left(\frac{\$168\,380}{\$640\,000}\right) \times 100 = 26.31\%$$
*(Accept calculation using profit from operations: \$\frac{171\,380}{640\,000} \times 100 = 26.78\%\$ if formula stated)*

**(ii) Return on capital employed (ROCE):**
$$\text{Capital employed} = \text{Total Equity} + \text{Non-current liabilities} = \$459\,380 + \$50\,000 = \$509\,380$$
$$\text{ROCE} = \left(\frac{\text{Profit from operations}}{\text{Capital employed}}\right) \times 100 = \left(\frac{\$171\,380}{\$509\,380}\right) \times 100 = 33.64\%$$

---

### (e) Evaluation & Recommendation

**Option 1: Rights Issue of Ordinary Shares**
- *Number of shares issued*: \$\frac{\$200\,000}{\$0.50} = 400\,000\text{ existing shares}\$. A 1-for-4 issue generates \$100\,000\text{ shares} \times \$0.80 = \$80\,000\$ (or if $$100\,000$ is raised, $125\,000$ shares at $$0.80\$).
- Advantages:
- Permanent capital with no obligation to repay principal.
- No fixed annual commitment to pay dividends; dividends can be reduced if cash flows are tight.
- Lowers financial risk and reduces gearing, improving solvency ratios.
- Disadvantages:
- Dilutes ownership and voting control if existing shareholders do not take up their rights.
- Rights issues can be more expensive to administer in terms of issue costs.
- Increases total equity base, potentially reducing earnings per share (EPS) in the short term.

Option 2: Issue of 8% Debentures
- Advantages:
- Existing shareholders retain proportional voting control with no dilution.
- Interest payments are allowable expenses against taxable profits (tax relief).
- Debenture holders have no share in surplus profits if the warehouse expansion is highly profitable.
- Disadvantages:
- Creates a mandatory legal commitment of fixed annual interest (\$\,8\% \times \$100\,000 = \$8\,000\text{ per year}\$), regardless of profitability.
- Increases gearing ratio and financial risk; defaults can lead to liquidation.
- Principal of $$100\,000$ must be redeemed in 2035, requiring liquid funds.

**Recommendation:**
Aventis Retail Ltd is currently highly profitable (ROCE of $33.64\%$ and operating profit of $$171\,380\$), easily covering its existing finance costs of $$3\,000$. However, issuing $$100\,000\$ in \$8\%\$ debentures increases annual finance costs to $$11\,000$, which is still well covered. If the directors wish to preserve ownership structure and avoid dilution while taking advantage of high operating returns, Option 2 (Debentures) is preferable. Alternatively, if the directors seek to avoid debt risk and preserve cash flows during construction, Option 1 (Rights Issue) is advised.

(a) Structured Workings [6 marks total]
- (i) Cost of sales: 1 mark for closing inventory adjustment ($$45\,600\$), 1 mark for final cost of sales ($$320\,400$). [2]
- (ii) Distribution costs: 1 mark for depreciation portion ($60\% \times $14\,400 = $8\,640$), 1 mark for total with accrual ($$61\,280\$). [2]
- (iii) Administrative expenses: 1 mark for irrecoverable debt and allowance adjustment ($$3\,000 - $20 = $2\,980$), 1 mark for correct aggregation including prepayments and depreciation ($$86\,940\$). [2]

**(b) Statement of Profit or Loss [8 marks total]**
- Revenue: 1 mark [1]
- Cost of sales (OF from (a)): 1 mark [1]
- Gross profit: 1 mark [1]
- Distribution costs (OF from (a)): 1 mark [1]
- Administrative expenses (OF from (a)): 1 mark [1]
- Profit from operations (OF): 1 mark [1]
- Finance costs ($$3\,000$): 1 mark [1]
- Profit for the year: 1 mark [1]

(c) Statement of Changes in Equity [5 marks total]
- Opening balances row correct: 1 mark [1]
- Profit for the year correctly placed in retained earnings column: 1 mark [1]
- Transfer of $$15\,000\$ between retained earnings and general reserve: 1 mark [1]
- Dividends paid ($$10\,000$) deducted from retained earnings: 1 mark [1]
- Correct closing totals across all columns: 1 mark [1]

**(d) Ratios [4 marks total]**
- (i) Profit margin formula (1 mark) + correct value $26.31\%$ (1 mark) [2]
- (ii) ROCE formula (1 mark) + correct value $33.64\%$ (1 mark) [2]
(Own figure applied sequentially from (b) and (c))

(e) Evaluative Advice [7 marks total]
- Option 1 (Rights issue): Up to 3 marks for discussion of advantages/disadvantages (1 mark per valid point: dilution, fixed cost absence, permanent capital, cost of issue). [max 3]
- Option 2 (Debentures): Up to 3 marks for discussion of advantages/disadvantages (1 mark per valid point: financial risk/gearing, mandatory interest, tax efficiency, repayment obligation). [max 3]
- Recommendation: 1 mark for a justified, clear choice based on the arguments made. [1]

(a) Updated Cash Book (Bank columns only)

$$\begin{array}{|l|l|r||l|l|r|}
\hline
\textbf{Date} & \textbf{Details} & \textbf{\$} & \textbf{Date} & \textbf{Details} & \textbf{\$} \hline
2025 & & & 2025 & & \\
\text{Mar 31} & \text{Maya (Credit transfer)} & 620 & \text{Mar 31} & \text{Balance b/d} & 1\,420 \\
\text{Mar 31} & \text{Trade payable (Correction of error: } 650 - 560) & 90 & \text{Mar 31} & \text{Bank charges} & 145 \\
\text{Mar 31} & \text{Balance c/d} & 1\,675 & \text{Mar 31} & \text{Insurance (Direct debit)} & 380 \\
& & & \text{Mar 31} & \text{J. Dale (Dishonoured cheque)} & 290 \\
& & & \text{Mar 31} & \text{Loan interest (Standing order)} & 150 \\
\hline
& & 2\,385 & & & 2\,385 \\
\hline
& & & 2025 & & \\
& & & \text{Apr 1} & \text{Balance b/d} & 1\,675 \\
\hline
\end{array}$$

---

(b) Bank Reconciliation Statement as at 31 March 2025

$$\begin{array}{|l|r|r|}
\hline
\textbf{Details} & \textbf{\$} & \textbf{\$} \\
\hline
\text{Balance as per bank statement (overdrawn)} & & (2\,145) \\
\text{Add: Uncredited deposits (lodgements)} & & 1\,700 \\
\hline
& & (445) \\
\text{Less: Unpresented cheques:} & & \\
\quad \text{Cheque No. 4088} & 840 & \\
\quad \text{Cheque No. 4092} & 390 & (1\,230) \\
\hline
\textbf{Balance as per updated cash book (overdrawn)} & & \mathbf{(1\,675)} \\
\hline
\end{array}$$

(Alternative format starting from cash book balance is also fully acceptable):
$$\begin{array}{|l|r|r|}
\hline
\textbf{Details} & \textbf{\$} & \textbf{\$} \\
\hline
\text{Balance as per updated cash book (overdrawn)} & & (1\,675) \\
\text{Add: Unpresented cheques } (840 + 390) & & 1\,230 \\
\hline
& & (445) \\
\text{Less: Uncredited deposits} & & (1\,700) \\
\hline
\textbf{Balance as per bank statement (overdrawn)} & & \mathbf{(2\,145)} \\
\hline
\end{array}$$

---

(c) Reasons for preparing a bank reconciliation statement:
1. To identify and correct errors made in the cash book or by the bank.
2. To assist in the prevention and detection of fraud, theft, or misappropriation of funds.
3. To ascertain the true and accurate bank balance for presentation in the statement of financial position.
4. To identify omitted transactions (e.g., bank charges, interest, standing orders, direct debits) and ensure the cash book is brought up to date.
5. To identify timing differences such as unpresented cheques and uncredited deposits.

(Any 3 points)

---

(d) Differences:
- Unpresented cheque: A cheque drawn/issued by the business and entered on the credit (payment) side of the cash book, but which has not yet been presented to the bank for clearance by the payee.
- Uncredited deposit: Cash or cheques received and entered on the debit (receipt) side of the cash book, but which have not yet been processed and credited to the account on the bank statement by the bank at the reconciliation date.

(a) Updated Cash Book [5 marks]:
- Opening balance $1 420 Cr [1]
- Maya (Credit transfer) $620 Dr [1]
- Correction of error $90 Dr [1]
- Bank charges ($145), Insurance ($380), Dishonoured cheque ($290), Loan interest ($150) credited [1 mark for all 4 items correct]
- Closing balance c/d and b/d $1 675 Cr [1 OF] (Awarded only if opening balance is on credit side and arithmetic is correct)

(b) Bank Reconciliation Statement [5 marks]:
- Starting balance as per bank statement $(2 145) or as per cash book $(1 675) [1]
- Addition of uncredited deposit $1 700 (or subtraction if starting from cash book) [1]
- Identification of both unpresented cheques ($840 and $390 / total $1 230) [1]
- Correct treatment (subtraction if starting from bank statement / addition if starting from cash book) of unpresented cheques [1]
- Final reconciled balance correctly derived and labelled [1 OF]

(c) Importance of regular bank reconciliation [3 marks]:
- [1 mark] per valid, distinct reason up to a maximum of 3 marks:
- Identifies errors in the cash book / bank records
- Detects fraud / embezzlement / unauthorised withdrawals
- Determines the correct bank balance for the financial statements
- Highlights stale / unpresented cheques and delays in bank processing
- Ensures all direct bank entries (charges, interest, standing orders) are updated in accounting records

(d) Distinctions [2 marks]:
- Unpresented cheque: Cheque paid out/issued by the business and recorded in the cash book, but not yet presented/cleared by the bank [1].
- Uncredited deposit: Receipt recorded in the cash book and deposited, but not yet cleared/credited on the bank statement by the bank [1].

(a) General Journal

| Date | Details | Debit ($) | Credit ($) |
|---|---|---|---|
| 2024 Dec 31 | L. Gomez | 450 | |
| | Suspense | | 450 |
| | *(To correct undercast on customer account: $720 - $270)* | | |
| Dec 31 | Suspense | 1 200 | |
| | Rent receivable | | 1 200 |
| | (To record unposted credit entry for rent received) | | |
| Dec 31 | Suspense | 680 | |
| | Purchases returns | | 680 |
| | *(To correct debit entry in purchases returns: $340 \times 2)* | | |
| Dec 31 | Insurance | 850 | |
| | Bank | | 850 |
| | *(To record omitted payment of insurance)* | | |
| Dec 31 | Motor vehicle repairs | 410 | |
| | Motor vehicles | | 410 |
| | *(To correct error of principle)* | | |

---

**(b) Suspense Account**

| Date | Details | $ | Date | Details | $ |
|---|---|---|---|---|---|
| 2024 | | | 2024 | | |
| Dec 31 | Rent receivable | 1 200 | Dec 31 | Difference as per trial balance | 1 430 |
| Dec 31 | Purchases returns | 680 | Dec 31 | L. Gomez | 450 |
| | **Total** | **1 880** | | **Total** | **1 880** |

---

**(c) Statement of Corrected Profit for the year ended 31 December 2024**

| Details | $ | $ |
|---|---|---|
| Draft profit for the year | | 42 600 |
| Add: | | |
| Error 2: Rent receivable unrecorded | 1 200 | |
| Error 3: Correction of purchases returns | 680 | 1 880 |
| | | 44 480 |
| Less: | | |
| Error 4: Unrecorded insurance expense | (850) | |
| Error 5: Motor vehicle repairs expense | (410) | (1 260) |
| Corrected profit for the year | | 43 220 |

(Note: Error 1 affects only customer ledger / trade receivables and does not affect profit).

---

(d) Errors not affecting trial balance (any two):
1. Error of omission: A transaction is completely left out of the accounting records (e.g. neither debit nor credit entry is made).
2. Error of principle: A transaction is entered in the wrong class of account (e.g. treating capital expenditure as revenue expenditure).
3. Error of commission: A transaction is posted to the correct side of the wrong account within the same class (e.g. debiting customer A instead of customer B).
4. Error of original entry: An incorrect figure is entered in a book of prime entry and posted to both ledger accounts.
5. Complete reversal: The correct amounts are entered on the incorrect sides of both ledger accounts.
6. Compensating error: Two separate errors of equal amounts cancel each other out.

(a) 1 mark for each fully correct journal entry (debit, credit and correct amount) [5 marks total]:
- Dr L. Gomez $450, Cr Suspense $450 (1)
- Dr Suspense $1 200, Cr Rent receivable $1 200 (1)
- Dr Suspense $680, Cr Purchases returns $680 (1)
- Dr Insurance $850, Cr Bank $850 (1)
- Dr Motor vehicle repairs $410, Cr Motor vehicles $410 (1)

(b) Suspense Account [4 marks total]:
- Opening balance / Difference per trial balance: $1 430 Credit (1)
- L. Gomez: $450 Credit (1 OF from journal)
- Rent receivable: $1 200 Debit (1 OF from journal)
- Purchases returns: $680 Debit (1 OF from journal)

(c) Statement of Corrected Profit [4 marks total]:
- Draft profit $42 600 (no mark alone)
- Add Rent receivable +$1 200 (1)
- Add Purchases returns +$680 (1)
- Less Insurance -$850 AND Less Motor repairs -$410 (1 for both correct deductions)
- Corrected profit $43 220 (1 OF - dependent on at least 2 attempts at error adjustments)

(d) Identification and explanation of errors not affecting trial balance [2 marks total]:
- 1 mark for each correctly identified and explained error (max 2 marks).

(a) Two assumptions of Cost–Volume–Profit (CVP) analysis:

1. Constant unit selling price and variable cost per unit: It is assumed that selling price per unit and variable cost per unit remain constant at all levels of output (i.e. no volume discounts on sales or bulk purchase discounts on materials).
2. Linear cost behaviour / Clear cost classification: Costs can be strictly split into fixed and variable elements, and fixed costs remain constant in total over the relevant range of activity.
3. (Alternative acceptable point): Inventory levels / Output equals sales: It is assumed that production volume exactly equals sales volume, so there are no changes in opening and closing inventory levels.

---

(b) (i) Contribution per unit and per machine hour:

$$\begin{array}{lrrr}
\hline
& \text{Alpha} & \text{Beta} & \text{Gamma} \\
& \$ & \$ & \$ \\
\hline
\text{Selling price} & 120 & 140 & 90 \\
\text{Less variable costs:} & & & \\
\text{Direct materials} & (32) & (24) & (16) \\
\text{Direct labour} & (30) & (45) & (15) \\
\text{Variable overheads} & (10) & (15) & (9) \\
\hline
\textbf{Total variable cost per unit} & \mathbf{72} & \mathbf{84} & \mathbf{40} \\
\hline
\textbf{Contribution per unit} & \mathbf{48} & \mathbf{56} & \mathbf{50} \\
\hline
\text{Machine hours per unit} & 2.0 & 4.0 & 1.0 \\
\textbf{Contribution per machine hour} & \mathbf{\$24.00} & \mathbf{\$14.00} & \mathbf{\$50.00} \\
\hline
\textbf{Ranking} & \mathbf{2^{\text{nd}}} & \mathbf{3^{\text{rd}}} & \mathbf{1^{\text{st}}} \\
\hline
\end{array}$$

---

(b) (ii) Optimal Production Plan and Maximum Monthly Profit:

Total machine hours required for all demand:
$$(1\,200 \times 2.0) + (800 \times 4.0) + (1\,500 \times 1.0) = 2\,400 + 3\,200 + 1\,500 = 7\,100 \text{ hours}$$
Available hours = $4\,500$ hours (Machine hours are the limiting factor).

Allocation of machine hours according to ranking:

1. **$1^{\text{st}}$ Gamma:** $1\,500 \text{ units} \times 1.0 \text{ hour} = 1\,500 \text{ hours}$
- Hours remaining $= 4\,500 - 1\,500 = 3\,000 \text{ hours}$
- Contribution $= 1\,500 \times $50 = $75\,000$

2. **$2^{\text{nd}}$ Alpha:** $1\,200 \text{ units} \times 2.0 \text{ hours} = 2\,400 \text{ hours}$
- Hours remaining $= 3\,000 - 2\,400 = 600 \text{ hours}$
- Contribution $= 1\,200 \times $48 = $57\,600$

3. **$3^{\text{rd}}$ Beta:** $\frac{600 \text{ hours}}{4.0 \text{ hours/unit}} = 150 \text{ units}$
- Contribution $= 150 \times $56 = $8\,400$

Profit Calculation:
$$\begin{array}{lr}
\hline
& \$ \\
\hline
\text{Contribution from Gamma } (1\,500 \times \$50) & 75\,000 \\
\text{Contribution from Alpha } (1\,200 \times \$48) & 57\,600 \\
\text{Contribution from Beta } (150 \times \$56) & 8\,400 \\
\hline
\textbf{Total contribution} & \mathbf{141\,000} \\
\text{Less: Budgeted fixed overheads} & (65\,000) \\
\hline
\textbf{Maximum monthly profit} & \mathbf{76\,000} \\
\hline
\end{array}$$

---

(c) Revised Monthly Profit with External Purchase:

- Unsatisfied demand for Beta $= 800 - 150 = 650 \text{ units}$.
- Maximum supplier supply $= 650 \text{ units}$.
- Contribution per bought-in unit of Beta $= \text{Selling price } ($140) - \text{Purchase cost } ($100) = $40$ per unit.

**Revised Statement of Profit:**
$$\begin{array}{lr}
\hline
& \$ \\
\hline
\text{Contribution from internal production (from (b)(ii))} & 141\,000 \\
\text{Contribution from bought-in Beta } (650 \text{ units} \times \$40) & 26\,000 \\
\hline
\textbf{Total revised contribution} & \mathbf{167\,000} \\
\text{Less: Budgeted fixed overheads} & (65\,000) \\
\hline
\textbf{Revised monthly profit} & \mathbf{102\,000} \\
\hline
\end{array}$$

*(Note: Revised profit is $$102\,000\$, representing an increase of $$26\,000$ per month).*

---

**(d) Recommendation and Justification:**

**Option 1: Accept the supplier's offer to buy in 650 units of Beta**
*Advantages:*
- Increases monthly profit by $$26\,000\$ (from $$76\,000$ to $$102\,000\$).
- Fully satisfies market demand for Beta (\$800\$ units), preventing customer dissatisfaction and preserving market share.

*Disadvantages:*
- Lower contribution per unit on bought-in units ($$40$ compared to $$56\$ internally).
- Loss of direct control over product quality, which could harm the company's brand reputation if the external units are defective.
- Reliance on an external supplier creates delivery risks (lead times, supply delays).

Option 2: Reject the offer and produce internally only
Advantages:
- Full internal quality control maintained across all products sold.
- Avoids dependence on third-party suppliers and protects proprietary production methods.

Disadvantages:
- Lost potential profit of $$26\,000$ per month.
- Severe unmet market demand for Beta ($650$ units unfulfilled), risking loss of long-term customers to competitors.

**Recommendation:**
Kestrel Manufacturing Ltd should **accept** the supplier's offer, provided strict quality inspection agreements and delivery guarantees are put in place, as it substantially increases monthly profits by $$26\,000$ while maintaining 100% customer order fulfillment.

(a) Assumptions of CVP analysis [Max 4 marks]
- 1 mark for identifying an assumption + 1 mark for explanation (up to 2 marks per assumption, max 2 assumptions):
- Unit selling price remains constant irrespective of sales volume (1) because market conditions are assumed stable / no price discounting (1).
- Unit variable costs remain constant (1) because direct input costs do not change / no bulk discounts (1).
- Total fixed costs remain constant throughout the relevant range of activity (1).
- Costs can be accurately separated into fixed and variable components (1).
- Volume of production equals volume of sales / inventory levels remain unchanged (1).

(b) (i) Contribution per unit and per machine hour [6 marks]
- 1 mark for correct unit variable cost of all three products (Alpha $$72\$, Beta $$84$, Gamma $$40\$).
- 1 mark for correct contribution per unit for all three products (Alpha $$48$, Beta $$56\$, Gamma $$50$).
- 1 mark each for contribution per machine hour:
- Alpha: $$24.00\$ (1)
- Beta: $$14.00$ (1)
- Gamma: $$50.00\$ (1)
- 1 mark for correct ranking (1st Gamma, 2nd Alpha, 3rd Beta) (1).

(b) (ii) Optimal production plan and profit [6 marks]
- 1 mark for identifying shortfall in machine hours (\$7\,100\$ required vs \$4\,500\$ available).
- 1 mark for Gamma production: \$1\,500\$ units (\$1\,500\$ hrs).
- 1 mark for Alpha production: \$1\,200\$ units (\$2\,400\$ hrs).
- 1 mark for Beta production: \$150\$ units (\$600\$ hrs).
- 1 mark for total contribution: $$141\,000$ (or OF).
- 1 mark for maximum profit: $$76\,000\$ (or OF).

**(c) Revised monthly profit [7 marks]**
- 1 mark for identifying quantity of Beta to buy in: \$650\$ units (\$800 - 150\$).
- 2 marks for contribution per unit of bought-in Beta: $$140 - $100 = $40$ (1 mark for method, 1 mark for accuracy).
- 1 mark for total contribution from bought-in Beta: $650 \times $40 = $26\,000$.
- 1 mark for revised total contribution: $$141\,000 + \$26\,000 = \$167\,000\$ (OF).
- 1 mark for deduction of fixed overheads $$65\,000$.
- 1 mark for revised monthly profit: $$102\,000\$ (OF).

(d) Evaluative advice [7 marks]
- Max 3 marks for advantages/disadvantages of accepting the offer:
- Financial gain: profit increases by $$26\,000$ (1)
- Customer satisfaction/market share maintained by meeting all demand (1)
- Risk of poor quality from supplier (1)
- Delivery reliability risk / stockouts (1)
- Max 3 marks for advantages/disadvantages of rejecting the offer:
- Retains complete control over production and quality standards (1)
- Avoids supplier dependence / potential future price increases (1)
- Loss of $$26\,000$ profit / inability to satisfy $650$ units of demand (1)
- 1 mark for clear, justified recommendation based on arguments presented.